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Why Blue States May Not Be Able to Game the New Tax System

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By Michael Rainey

January 5, 2018

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Some high-tax states are looking for ways to limit or even negate the new $10,000 limit on state and local tax deductions imposed by the Republican tax bill. Options being explored by New York, California and other blue states include direct legal challenges to the constitutionality of the new rules, relying more on payroll taxes and less on income taxes, and replacing state income taxes with charitable deductions to state and local governments.

But there’s no guarantee that any of these alternatives would actually work, and there’s good reason to think the federal government would challenge them for both legal and financial reasons. Tax cuts will reduce federal revenues by more than $1 trillion over the next 10 years, and if state workarounds are effective, that figure would grow substantially.

National Economic Council Director Gary Cohn told Bloomberg Friday that the Trump administration will be watching what the states do — and could step in to block plans that would cut into federal tax receipts. “I understand what they’re trying to do for their cities and their states and their taxpayers,” Cohn said. “We at the federal government still have to collect revenue.”

The conservative Tax Foundation published a paper Friday examining the “Rube Goldbergesque” strategies blue states are considering to avoid the new deduction limits, with an emphasis on potential legal challenges from the IRS. The pessimistic conclusion of analyst Jared Walczak: “The proposals are inventive and in many respects quite interesting, but for both legal and practical reasons, they are unlikely to succeed.”